Southwest Airlines (NYSE:LUV) is the largest domestic carrier by total passengers, carrying over 110 million passengers over 1 million flights. [1]

A key component of the Southwest business strategy is its low cost structure, which is designed to allow it to profitably charge low fares.[2] The company has lower unit costs, on average, than most major carriers. LUV's low cost structure is currently facilitated its reliance upon a single aircraft type, its operationally efficient point-to-point route structure, and its highly productive Employees. The use of a single aircraft type, the Boeing 737, enables Southwest to simplify scheduling, maintenance, flight operations, and training activities. The company has been profitable since 1972, an unprecedented record in the industry..[2]

Company Overview

Southwest Airlines offers short domestic-only flights with minimal service and a simple, cheap fare structure.[2] Southwest's low cost structure enables the company to offer low prices to its customers.

Key Trends and Forces

Airline industries are more sensitive to the economy than other industries

Typically, airline companies and aircraft manufacturers are more prone to swings in revenue and equity market prices due to the release of economic indicators.[4] Consumers tend to reduce travel if personal economic conditions are suboptimal, forcing airlines to cut capacity and production. Indicators such as unemployment indices, personal income, and even home sales affect airline industries in exaggerated fashion.

Southwest's key to financial success is its fuel hedging, where the company agrees to future fuel contracts that secure a particular price. As a result of different hedging strategies at each of the major airlines, oil fluctuations impact each of them differently. Southwest hedges more oil than any other airline, which has ensured the lowest prices on jet fuel during significant oil spikes. Southwest hedges around 70% of its fuel needs hedged, while most other major airlines have only between 20% and 30% of their fuel hedged.[5] However, the downside to hedging extensively is being subject to overpaying for oil when oil prices plummet or pursue a downtrend.

International Expansion Promotes Growth

Southwest is pursuing plans to expand its U.S. only service to include flights to Canada and Mexico.[6] By pursuing a code-sharing agreement with regional airlines, the company will sell tickets on each other's flights and share the revenue. Southwest's code-sharing agreements are lower risks because they enable the company to expand its service without adding aircraft and employees.[6] Southwest has also continued to expand domestically.

Competition

Southwest competes against many low-cost carriers or low-cost subsidiaries of larger carriers. Southwest's main low-cost carrier competitors are AirTran Holdings (AAI) and JetBlue Airways (JBLU). Its other competitors include American Airlines (AMR) (in Chicago, Texas, Los Angeles, and Miami), and United Continental Holdings (UAL). Because of its efficient cost-saving strategies, Southwest's 37-year streak of profitability is unmatched in the airline industry.[7]

AirTran Holdings (AAI): AirTran Holdings (Nasdaq:AAI) is one of America’s largest low-fare passenger airlines. The airline has managed to achieve low operating costs despite relying on a hub-and-spoke system, in which most of its flights originate and terminate at its hub in Atlanta, Georgia. Given AirTran's continued reliance on the hub and spoke system, airline management has cited other operational factors as cause for the airline having a cost structure that is among the lowest in the industry.[8]

American Airlines (AMR): AMR is the parent company of American Airlines, the second largest airline in the world based on available seat miles and revenue passenger miles On an average day, American Airlines flies approximately 3,400 flights between 250 countries. The company has been recording net losses for many years and has experiences very weak demand for air travel driven, particularly during significant economic downturns. [9]

Delta Air Lines Inc. (DAL): Delta Air Lines is the 2nd largest passenger airline in the world by available seat miles. In recent years, the company has faced financial difficulties due to price competition from discount airlines like JetBlue and Southwest. This has limited Delta's ability to raise prices to their natural supply/demand and cost reflective levels. As a result, Delta was forced into bankruptcy in September of 2005. Since exiting bankruptcy on April 30, 2007, the company has followed a revised operating strategy calling for a network shift towards more profitable international routings. [10]

JetBlue Airways (JBLU): JetBlue Airways is the 8th largest airline in the U.S. by revenue passenger miles. JetBlue differentiates itself from other airline travel companies with its low fares, made possible by low distribution and operating costs - largely due to the fact that it has the youngest fleet in all domestic airlines. JetBlue Airways specializes in cheap point-to-point flights with high levels of customer service to over 50 destinations in around 20 states, Puerto Rico, Mexico, and the Carribean.[11]

United Continental Holdings (UAL) United Continental Holdings (UAL) is a holding company and its principals are United Airlines and Continental Airlines. The merger between United Airlines and continental took place on October 1st, 2010. Due to the merger, United Continental Holdings is the largest airline in the world. The combined entity operates approximately 5,800 flights a day to more than 375 U.S. domestic and international destinations.The company's hub and spoke system allows it to transport passengers between a large number of destinations with substantially more frequent service than if each route were served directly.

US Airways Group (LCC) US Airways is a major domestic air carrier approximately operates 3,800 flights to 230 destinations across the U.S., Canada, the Caribbean, Latin America and Europe. The company’s finances suffered considerably due to reduced air travel following September 11th, forcing the airline to declare bankruptcy in 2002. However, unlike other carriers that improved and emerged stronger following Chapter 11 protection, US Airways never fully recovered. The combination of high fuel costs and tough labor negotiations forced the company into a merger with America West in 2005. While the US Airways name was maintained for brand purposes, the merger actually left America West executives and stockholders with more control over the new company.[12]